J. Lyons Fund Management, Inc. Newsletter
||Posted October 31, 2011|
The 'Can't Afford Retirement' Plan
1: Most investors are operating a fatally flawed plan
...or no plan at all.
Following the recent kabuki theater that is the European Union’s attempt at resolving their debt crisis has been fascinating. As money managers, what strikes us most is how maddening it must be to attempt to invest based on the whims of the EU news, or any news flow for that matter (including earnings and economic releases). It is especially difficult for individual investors but also for “professionals” as well. Consider the recent 8 trading days below, for example. The following are actual daily headlines from a major financial news outlet along with the daily point change of the Dow Jones Industrial Average:
|October 17||Dow -248||U.S. Stocks Fall Sharply on Lower Europe Optimism|
|October 18||Dow +180||U.S. Stocks Lifted Further by Europe Report|
|October 19||Dow -72||U.S. Stocks Fall on Europe Unease|
|October 20||Dow +37||U.S. Stocks Tip Higher as Europe Exerts Pull|
|October 21||Dow +267||U.S. Stocks Rally on Hopes for Europe Plan|
|October 24||Dow +105||U.S. Stocks Rise on Europe|
|October 25||Dow -207||U.S. Stocks Drop on Europe|
|October 26||Dow +162||U.S. Stocks Rally on Europe-Related Reports|
Try figuring out what the market will do the following day from those headlines. Aside from the journalistic laziness, it is no wonder individual investors are disillusioned with the stock market. Making investment decisions based on news flow is a good way to lose capital very quickly. And yet, that is what many investors do, i.e., they “wing it”.
And it is no wonder individuals are disillusioned with Wall Street “establishment” advice. All too often, it seems to be influenced by the same headline forces. “Experts” from like-minded investment companies are continuously trotted out onto financial news channels to give generic, unhelpful statements in an attempt to “analyze” these same headlines. The next day a new batch of like-minded analysts are herded onto the channel and do the same, often contradicting prior advice to fit the headlines that day.
amateurs and professionals alike, winging investment decisions based on
which way the headline winds are blowing is a futile endeavor. To do so
with any success assumes each of the following conditions can be
applied confidently and consistently:
- You can trust the accuracy of the story.
- You can correctly analyze the ramifications of the story.
- You can correctly chart the investment course that will profit (or not) from the story.
- You can implement that investment strategy before that advantage disappears.
We have over a half century of money management experience and we watch the market nearly every minute of every trading day. That said, we probably only have a reasonably high degree of confidence in #1 and #2. We have only moderate confidence in #3 and absolutely no confidence in #4. We would not consider that a viable investment strategy for us, let alone for a retail investor whose schedule does not allow for constant monitoring of the news wire during market hours.
The problem with trying to invest based on news flow is that the information is “baked into” the market as soon as the news is disseminated, at a minimum. Just as likely, someone has been privy to said information before it was officially disseminated. Furthermore, even if everyone was on an even playing field, the stock market is notorious for its discounting ability. Today’s news has, for all intents and purposes, probably been baked into the market for days or weeks or even months. In fact, it is commonly thought that the market discounts the situation 6 months in advance. Yes, there are exceptions when unanticipated events occur which cause temporary dislocations in the market. However, to be able to profit based on news flow is still near impossible; and to think it can be done consistently is the height of folly.
So how can one invest profitably if markets and headlines are so fickle? First off, it requires an investment plan. Most investors are operating either without a plan or with one that is fatally flawed.
“Failing to plan is planning to fail.”
- Alan Lakein
Most stock market participants do not have an investment plan. How is that not an exaggeration? Over 50 million Americans own a 401(k) yet the vast majority of them do not have any meaningful, much less effective, direction with regard to investing it. And these are the people most reliant on their retirement plans for their income. According to a 2010 MassMutual survey, only 10% of 401(k) participants employ the services of an investment advisor. Notwithstanding the quality of the advisor, at least they are making an attempt. The other 90%, sadly, are on their own.
In our experience, almost without exception, 401(k) investors tell us they have no idea how to invest their plan. This is true for blue collar workers as well as corporate executives. It’s not that these folks are not smart enough to make the investment decisions. We have dealt with many highly intelligent individuals whose 401(k)’s are basically on auto-pilot because they simply find the task too daunting. Investing is an endeavor that requires a constant and disciplined commitment in order to make it work. For a 401(k) participant to be expected to implement a successful investment plan while fulfilling the obligations associated with their full-time job is not at all realistic.
Unfortunately, the shift over the past few decades from defined benefit plans (pensions) to defined contribution plans (401(k)’s) has indeed placed such expectations on participants. Instead of having a guaranteed payout at retirement via a professionally-managed pension plan, the burden is squarely on the participant to make all the investment decisions in their plan, and thus, to determine the fate of their retirement nest-egg.
To make matters worse, most 401(k)’s are held and administered at the custodian of the employer’s choosing and thus unmovable by the participant while they are still employed. This makes it exceedingly difficult for participants to attain quality investment assistance. Investment advisors usually get compensated through commissions or fees taken directly from their client’s account. However, since 401(k)’s are not under the advisor’s custody, that is not possible. While there are ways to circumvent this barrier, it essentially prevents 99% of quality investment advisors from easily assisting 99% of 401(k) participants.
So the nation’s predominate retirement system certainly has not helped the prospects for future retirees. However, the inability to move a 401(k) account and the difficulty in acquiring effective investment assistance is not an excuse for one’s 401(k) to be without an investment plan. Yes, the burden of directing the investment of one’s retirement funds falls on the participant. And yes, considering the difficulty of the task, it is indeed a burden. However, what is the alternative? If a participant neglects to address the management of their retirement account, they may fail to accumulate enough money for retirement. Unfortunately, a 401(k) participant is not “too big to fail”. Their retirement is not going to be bailed out.
Now let's be perfectly clear about one thing. Having one’s 401(k) on auto-pilot is not a plan. Settling on a few funds in which to allocate one’s contributions and forgetting about it for the next 10-15 years is not going to cut it. It is questionable that the allocation was even appropriate when it was set up, doubtful that it is appropriate now and definitely not appropriate for all markets. This is particularly true in the midst of an ongoing secular bear market during which all rallies eventually give back their gains. Not only will various investment options within a 401(k) be more appropriate than others during a secular bear but during a significant portion of the time, none of the equity investments will be appropriate.
Along the same lines, “investing for the long-term” is not a plan. The investment establishment preaches this phrase ad-nauseum. However, in reality, all it means is that the investor’s portfolio is on auto-pilot because they don’t know how to avoid losing money in the short-term -- and neither does their advisor, if they have one. Sure, everyone wants their investments to grow over the long-term but how does ignoring them along the way guarantee that one will accomplish that goal? The best way to grow one’s investments in the long-term is to reduce risk and avoid taking big losses along the way. Waiting 30 years to determine if an investment plan has worked or not is the epitome of risk-taking.
“Everyone has a plan 'till they get punched in the mouth.”
- Mike Tyson
Most people with at least a casual interest in directing their investments think they have a plan. Thanks to the Wall Street establishment, sadly most are wrong. Individual investors have been fed the establishment party line of “buy-and-hold” as their investment plan. Diversify by buying a little of this and a little of that, they say, and one is on their way to retirement bliss (of course, they don’t mind a bit that they’re making fees off of those holdings). Heck, some companies advise investors to pick their own stocks and funds -- it’s really not that difficult, they say (and again, of course, they don’t mind making fees off of the transactions.)
So what is wrong with this plan? Nothing if it is the late 1990's and the stock market is rising 20% a year. That is not reality, however. Investing is not shadow-boxing; there is an opponent in the ring with you. The stock market is an adversary, not a punching bag. And in 2000, just as investors were pouring the most money into the stock market in its history, they got punched in the mouth. From March of that year until 2002, the S&P 500 fell 50%. Even worse, the Nasdaq, in which investors who thought they had a plan had invested much of their capital, fell 80% during that time.
Unfortunately, for those investors nearing retirement at the time, it was not just a punch in the mouth but a knockout. After decades of investing for retirement, they saw much of what they had saved completely wiped out…with no long-term hope of recovering it. And judging by money flows, most investors young enough to have hope of recovering their losses, not to mention eventually make sustainable gains, failed to learn from the experience. As investors again reached extremely high levels of equity investment in 2007, the market knocked them to the canvas again with another 50% loss.
Experiencing these drawdowns has introduced investors to real adversity. Hopefully, they have realized that much of what they were missing from their plan was a defense. They lacked risk controls to help them avoid incurring large losses. Having half of a potential plan (the “buy” part) can hurt just as much as having no plan at all.
If it is any solace (to the psyche, not to the bottom line), most advisors and analysts in the investment establishment only have half of a plan themselves. They too lack the risk-management portion of a viable plan. At least it appears that way as over 90% of the stock ratings by major brokerage firms are “buys” and being defensive to most Wall Street firms means cutting back their equity exposure by 5-10%.
"It takes as much energy to wish as it does to plan."
- Eleanor Roosevelt
It is understandable that investors were blind-sided by the bear market in 2000-2002 considering the big returns they were getting in the late 1990's. However, it is less acceptable if they fell victim again in 2007-2009. As the secular bear market moves well into its second decade, when will investors finally get tired of being punched in the mouth? After losing 20% in a matter of weeks last quarter? After the next 50% hit to their retirement account? Those jokes about 401(k)'s turning into 201(k)'s aren't that funny anymore.
Ignoring one's investment predicament is not an acceptable plan. Dreading the idea of opening one’s 3rd quarter statement is natural after such a hideous quarter. However, avoiding the matter is not going to fix the problem. Hoping and wishing that the stock market returns to its bull market heydays and bails out one's retirement is not a plan (and FYI, that ain't happening any time soon.) All the stress and consternation over whether one will have enough money for retirement is not going to fix the problem.
What will fix it is an investment plan. Establishing that plan will take accountability and action. Particularly in light of the continued difficult investment environment that we foresee for the remainder of the decade, we strongly encourage investors to overcome inertia, be proactive and take that action. This is true for participants who will need to rely solely on their 401(k) for retirement income as well as those investors who have considerable investment assets but have overlooked the management of their 401(k).
In Part 2 next month, we will discuss various components that are essential for an investment plan to have a chance at success. We're sorry to leave you hanging at this point, but perhaps some soul-searching is in order regarding the plan, or lack thereof, that is guiding your retirement investments.